Republic of Slovenia: Staff Report for the 2013 Article IV Consultation

KEY ISSUESContext: Slovenia is facing a deep recession resulting from a vicious circle of strainedcorporate and bank balance sheets, weak domestic demand, and necessary fiscalconsolidation. The headline deficit remains around 4¼ percent of GDP in 2013 excludingbank restructuring costs, and public debt—55 percent of GDP at the end of 2012—isincreasing rapidly. Concerns about growth, banks, and the fiscal gap and large fiscalcontingent liabilities have kept sovereign borrowing rates high. Based on the asset qualityreview (AQR) and stress tests (ST), the government is recapitalizing state-owned banks.Challenges: (i) building on the planned recapitalization, promptly restructure banks toensure financial stability; (ii) restructure the corporate sector to avoid a recurrence offinancial problems; (iii) pursue gradual fiscal consolidation over the medium term, includingvia further pension reform, to safeguard debt sustainability.Staff views: The independent AQR and ST and recapitalization are key milestones. However,only restructuring the corporate and bank sectors, including a thorough clean-up of bankbalance sheets, and reducing the role of the state in the economy can sustain durablegrowth. Without this, the bank recapitalization will be only a stop-gap—albeit expensive—measure. Corporate restructuring, involving debt-equity swaps to deleverage viablecompanies and liquidation of unviable ones, is needed. The bank asset managementcompany (BAMC) and the new insolvency law can facilitate this but more nonperformingloans (NPLs) than currently proposed should be transferred to the BAMC. The authorities'plan appropriately envisions a reduction in the general government deficit (excluding bankrestructuring and recapitalization costs) to 3½ percent of GDP in 2014 and below 3 percentof GDP in 2015, but additional, upfront measures of some 1 percent of GDP may be neededto achieve the 2014 target. In the medium term, additional consolidation is necessary toaddress the fiscal costs stemming from bank restructuring. In addition, pension reforms areneeded in response to unfavorable demographic trends.Authorities' views: After bank recapitalization, corporate restructuring facilitated bytransferring part of the bad assets to the BAMC and by the new insolvency law is a priority,but expanding corporates' access to credit is also important. Privatization of 15 companies,including Telekom, NKBM, Abanka, and (partly) NLB, will further improve governance. Whileacknowledging fiscal risks for 2014, the authorities are optimistic about the fiscal measures,and will consider corrective actions later in the year if needed. A second round of pensionreform will be considered after 2015 when the pension freeze will expire. Decisiveimplementation of reforms will decrease further the cost of borrowing.